In early March, the UK’s Supreme Court ruled in two cases concerning offshore vehicles, which were set up over a decade ago in Jersey and the Cayman Islands, that shares awarded to employees as bonuses should have triggered tax payments to the UK revenue authorities. In a fairly blunt assessment, the Supreme Court said that they “had no business or commercial rationale beyond tax avoidance.”
The media attention has focused on the legality of such schemes, which has been a recurring theme in many other cases. This oversimplifies the issue and overlooks a number of relevant considerations.
UK tax law, or most tax law for that matter, is exceptionally complex. An inevitable product of such complexity is a body of intelligent and highly educated individuals who are able to analyse domestic tax law in the wider context of the international fiscal landscape and devise intricate schemes that exploit the legislative cracks and crevices to minimise the tax liability of any given individual or organisation.
Similar schemes or structures have been openly referred to as being “legal” and, accordingly, assumed to be entirely legitimate for exploitation. This is a term that seems increasingly inappropriate when one considers how most tax planning schemes find their way on to the shelves. The use of the word “shelves” is intentional, as many of these products are commoditised, albeit there are more sophisticated versions that have elements of customisation.
If a scheme is designed or approved at great expense by a tax Queen’s Counsel or firm of highly respected accountants, this does not make it legal. At the head of the document setting out the terms of the scheme the word “OPINION” usually appears in bold, capital letters. The use of this word is not an accident. What this word implies is that what is being proposed is not rendered specifically illegal by the legislation as it stands. There is not likely to be a statement in the law permitting such a scheme, nor has there been a court decision declaring such a scheme to be legal according to the law as it currently stands. In fact, by definition, the nature of such structures normally places them outside the contemplation of the drafter. It is simply the opinion of one, albeit expert, person.
The problem occurs when this opinion finds its way into the hands of financial advisors and the word “legal” takes a decidedly liberal turn. It might well be used to support the legitimacy of a number of tax planning schemes marketed to a broad customer base as “legal.” It might seem like a subtle distinction, but it is an important one.
The UK revenue authority, HRMC, probably has the intellectual power of its private sector rivals, but given the volume and speed to market of such schemes, it lacks the capacity to deal with all schemes about which it has doubts. This is probably why it took over a decade for the UBS and Deutsche Bank schemes to be tested in the UK’s highest court. However, when one drills into the schemes, it is not the legality (in the sense of criminal tax evasion) which is in question. At its heart, is the question of whether the scheme produces the tax effects that it was designed to generate.
Currently, when one scheme is deemed not to produce such tax effects, it is mothballed, possibly restructured and the next idea is developed. A general theme of tax tribunals and the court system, in general, is that they are increasingly moving toward an interpretative approach to such cases, i.e. what the legislature intended when it drafted the law, as opposed to a strict reading of the law. This is likely to lead to more cases being settled in favour of HMRC as other recent cases have shown, but creates uncertainty in the minds of advisors and taxpayers.
The bedfellow of the “legal” issue is the phrase “aggressive tax planning.” Like many things, there is no definition, but the educated layman, and certainly those operating in the offshore financial services industry, are likely to recognise it when they see it.
Tax planning operates on a spectrum. At one end are well understood and entirely transparent tax mitigation techniques starting with efficient tax allowances and the like. The spectrum then moves through schemes until it finally ends up with schemes that are novel, supported by opinions and appear to play to the form, rather than the substance, of the arrangements.
It is only when they are tested by the court system that it is finally determined as to whether they “work.”